By Karen E. Spaeder
When it comes to paying for higher education, there are a variety of ways to foot the bill, ranging from grants and scholarships to federally funded student loans. However, for working students pursuing a degree, often the choices are limited in terms of the available college funding. Federal grants are needs-based, and working students often earn too much to qualify for them. And scholarships generally require an investment of time to apply, which may prove unrealistic for those who need money right away to pay for higher education costs. Increasingly, working adults are turning to student loans, but there are other options you may want to consider first.
As an alternative or a supplement to grants and scholarships, consider the many tax provisions that can help you offset the costs of higher education. While you won’t see money in your pocket immediately, a tax credit, deduction or other government assistance can make your higher education goals a reality—if you know what’s available to you as a taxpayer. Consider the following options, and consult your tax adviser for help in determining which ones make the most sense for you.
The following new tax credits, available for 2009 and 2010, are available to help offset the costs of higher education by directly reducing the amount of your total income tax you may have to pay. Be aware that you can elect only one of the credits for each student in any year. Certain income, filing status and other restrictions also apply. Ask your tax adviser which credit will be most beneficial to you, and talk with your school’s financial aid office for help in determining whether your school qualifies as an eligible institution.
American Opportunity Tax Credit
This credit offers a maximum credit of $2,500 for the first four years of postsecondary education. Forty percent of the credit may be refundable—meaning if the refundable portion of your credit is greater than your tax, the excess will be refunded to you. Qualified expenses include tuition and certain related expenses required for enrollment or attendance at an eligible educational institution—that is, any college, university, vocational school or other postsecondary educational institution eligible to participate in a U.S. Department of Education student aid program.
While the American Opportunity Tax Credit offers a larger credit for most taxpayers—the Hope Credit offers up to $1,800 for qualified education expenses, versus the American Opportunity’s $2,500—the Hope Credit offers greater relief for students who meet the special rules of the Midwestern disaster areas. Students enrolled in an eligible educational institution in a Midwestern disaster area may be able to claim a Hope Credit up to $3,600. The Hope Credit is nonrefundable, so if the credit is more than your tax, the excess will not be refunded to you. Additionally, the credit is available only for the first two years of postsecondary education.
Lifetime Learning Credit
This credit allows you to claim up to $2,000 for qualified education expenses, or $4,000 for students in Midwestern disaster areas. Unlike the American Opportunity and Hope credits, there is no limit on the number of years you may claim the Lifetime Learning Credit for each student. As with the Hope Credit, the Lifetime Learning Credit is nonrefundable.
Deductions and Other Assistance
Student Loan Interest Deduction
If your modified adjusted gross income is less than $75,000 ($150,000 if filing jointly), you can take advantage of a special deduction allowed for paying interest on a qualified student loan used for higher education. This deduction can reduce your taxable income by up to $2,500. Because the student loan interest deduction is taken as an adjustment to income, you can claim this deduction even if you don’t itemize.
Student Loan Cancellation and Repayment Assistance
If a loan is canceled (forgiven), generally you must include the forgiven amount in your gross income. However, under certain circumstances, your loan may qualify for tax-free treatment. To qualify, your loan must contain a provision that all or part of the debt will be canceled if you work for a certain period of time in certain professions and for a certain class of employers. To qualify for repayment assistance, you must work in public service occupations or in areas with unmet needs, such as health care providers in underserved areas, certain types of attorneys and classroom teachers in subject areas with shortages.
With this deduction—taken as an adjustment to income, as with the Student Loan Interest Deduction—you can reduce your taxable income by up to $4,000. Qualified expenses may include tuition and certain related expenses such as student activity fees, course-related books, supplies and equipment. Consider this deduction if you do not qualify for the American Opportunity, Hope or Lifetime Learning credits and your modified adjusted gross income is less than $80,000.
Employer Education Assistance
If your employer provides educational assistance, your employer should exclude those benefits from your wages, tips and other compensation shown in Box 1 of your Form W-2. You also do not need to include these benefits on your income tax return. You may exclude up to $5,250 of benefits under this provision. Check with your employer to determine whether your company offers a qualified educational assistance program.
With careful research and planning, you can significantly reduce your higher education costs simply by taking advantage of these available tax provisions. Because you will not see the money until you file your tax return, a tax credit may not work on its own for individuals who need money right away to pay for tuition, fees and other costs. However, if you combine the credits with other forms of educational financing, such as grants, scholarships and financial aid, then tax credits will be worth the delayed return.